Bank Failures, Capital Buffers, and Exposure to the Housing Market Bubble
48 Pages Posted: 6 Aug 2020 Last revised: 15 Dec 2021
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Bank Failures, Capital Buffers, and Exposure to the Housing Market Bubble
Date Written: December 15, 2021
Abstract
We develop housing overvaluation measures that are orthogonal to the local economic conditions and show that banks with greater exposure to such overvalued housing markets have higher mortgage delinquency and charge-off rates and significantly higher probabilities of failure during the crisis of 2007--09 even after controlling for standard bank characteristics. While high house prices relative to fundamentals present a greater likelihood of house price correction, we find no evidence that banks managed this risk by building stronger capital buffers. We also show that orthogonalized overvaluation measures are important in explaining individual mortgage loan defaults and could be used to improve risk management at banks.
Keywords: Residential real estate, bank failure, credit risk, mortgage risk, house price-to-income ratio
JEL Classification: G01, G21, G28, R31
Suggested Citation: Suggested Citation